Congratulations! You are a proud owner of an engraving business. However, you ar
ID: 2489020 • Letter: C
Question
Congratulations! You are a proud owner of an engraving business. However, you are using an aging rotary engraver to engrave plaques and trophies. The machine has been reliable, but does require regular maintenance and periodic replacement of parts. You have just found out that this engraver will no longer be supported by the manufacturer. This means that service and parts will be hard to get in the future and if it breaks it could take up to three weeks to get a new one up and running. You keep this machine running almost 8 hours a day, every day. Every day that the engraver is down will cost around $975 in lost income. If you have to buy a new engraver, it would cost around $25,000. You can get a one-year loan at 12% to buy a new engraver, but you worry that this is a lot of money to spend, especially since the old engraver is still working fine. You have to make a decision. In this discussion, pose you argument on whether you should purchase a new engraver now or wait until the old engraver breaks before ordering a new engraver? To help you construct your argument answer the following steps: 1.The local bank will loan you $25,000 for 1 year at an interest rate of 12% with only one payment due at the end of the year. If you borrow the full $25,000 for the new engraver, what will the total cost of the loan be? 2.Calculate the total amount of revenue (gross profit) that will be lost if the engraver breaks and is down for 18 business days. 3.If the engraving business makes $975 per day in revenue and generates a net profit of 25%, how much profit is generated per day? 4.Given a 25% profit margin and $975 per day in revenue, how many days would it take for the new engraver to earn back the total cost of purchase, if the entire net profit were allocated to pay for the unit? 5.What other factors should you consider in order to make a good business decision?
Explanation / Answer
1) Assuming simple interest, the interest expense on the loan in 1 year = 25000 x 12% = $3000
So total cost of the loan = $25000 + $3000 = $28000
2) If the old machine breaks down and 18 days are required to repair it, the total loss of revenue = 18 x $975 = $17750
3) Net profit = 25% of $975 = $243.75 per day.
4) Total cost of financing the new machine = $28000
profit made per day = $243.75
Number of days required to recover the total financing cost of the new machine at this rate of net profit
= $28000 / $243.75 per day
= 115 days.
5) The other factors that should be considered are:
1) If the new machine is not purchased, whether the old one will break down more than once in a year. Because in that case, the cost of maintenance and repairing the old machine will be much more than the total cost of the new machine.
2) If the new machine is purchased, the reliability of the machine to continue an uninterrupted operations, the accessibility to the spare parts of the new machine and for how many years the new supplier will provide the maintenance support for the new machine.
3) If there is any other additional cost that is associated with the new machine. This is important so that the company can maintain the same net profit with the new machine as it is earning with the new one.
4) If there is any salvage value of the old machine, then the total cost of the new machine will get reduced by that salvage value.
5) It should be ensured that there should not be any loss of revenue as well as the profit before the recovery of the entire cost of the new machine.